Educational Articles

Stock Screen: Debt Free Dividend Payers - February 8, 2013

Kevin Downing
| February 08, 2013

A debt-free balance sheet is often an indication of financial strength. Although leverage has certain benefits and is, in fact, advisable and appropriate for some industries, operating without debt materially increases a company’s financial flexibility. For example, in lean times, such as a recession, a balance sheet sans debt can allow a company to continue operations without interruption. This is a margin of safety that a highly-leveraged company may not have.

Investors using dividend income to pay living expenses should find such stocks of particular interest. Indeed, if a company, industry, or the entire economy should fall on hard times, a debt-free balance sheet increases the chances that a company will maintain its distribution unaltered. Thus, an investor’s “paycheck” won’t take a hit at the same time that the value of his or her portfolio is declining. Such dividend payments can allow the investor to ride out the bad times and the likely corresponding share-price decline. Although capital preservation is clearly important, sometimes the best way to conserve capital is to sit tight with a good company regardless of what the emotionally-driven stock market is doing. Dividend distributions supported by a strong financial structure make that easier to do.

To find such companies, we used the online screening tools of The Value Line Investment Survey to identify companies, such as T. Rowe Price Group, Inc. (TROW) that feature a dividend but carry no debt. Clearly, the screen could be altered to meet the needs of investors looking for a particular level of dividend payments or made more lenient for those who believe a little bit of debt is a good thing.

T. Rowe Price Group, Inc.

T. Rowe Price is a financial services company that provides global investment management services to individual and institutional investors through mutual funds and other investment portfolios, including separately managed accounts (SMAs), subadvised funds, and variable annuity life insurance plans. Its revenues depend largely on the total value and composition of assets under management (AUM) as well as fluctuations in financial markets. Assets are accumulated from third-party financial intermediaries that distribute its managed investment portfolios in the United States and other countries, individual U.S. investors, retirement plans, and global institutional investors. As of December 31, 2012, approximately 40% of its AUM were sourced from third-party financial intermediaries, with the remaining three distribution channels equally making up the balance. Investments include but are not limited to U.S. and international stocks, bonds, and money market mutual funds. The company currently has zero debt on the balance sheet and its dividend yield is a solid 2.1%.

T. Rowe recently released fourth-quarter results that were mostly in line with expectations. Earnings per share fell a penny short of Value Line analyst Frederick Harris’ estimate. Revenues rose 2.3% on a sequential basis, but this was still slightly below the consensus Wall Street expectation.

Overall, most world markets produced negative returns during the quarter, as consumer and corporate confidence fluctuated. According to the company, this was the result of changing opinions about the U.S. government’s ability to make progress on key economic issues.

Investors took out more money from equity funds than they put in during the quarter, creating net outflows. This is a rare occurrence for TROW since it’s considered by many to be one of the best asset managers in the business. Money was also taken out of SMAs, creating the largest decline in over ten years. This was likely due to concerns over the "fiscal cliff" and changing tax laws.

Recently, there has been some evidence that this outflow trend reversed in January. According to the Investment Company Institute, the seven days ended Jan. 23 was the third consecutive week that investors put money into U.S. equity mutual funds. Although the amount of inflows slowed somewhat from the prior two weeks, for the first three weeks of January, over $16 billion was added to equity funds. If this continues, the company will likely benefit as equity management commands higher fees, and, thus, should improve margins.

On the debt side, yields have been driven to near record lows due to a series of government stimulus programs. This has made the fixed income markets less appealing. The company said opportunities still exist in the fixed income markets, but risks are now rising.

Management is cautiously optimistic on the fundamentals of many global corporations, saying that balance sheets are generally in good shape, and many corporations are generating strong cash flow. Despite this fact, equity valuations appear reasonable. With the political and economic environments still in flux, volatility should also be expected.

Shares of T. Rowe Price are best left for investors looking to capitalize on general strength in global equity markets. Due to the aforementioned uncertainties, there is significant risk that the company will not meet our current expectations. Therefore, more conservative investors may wish to consider equities with greater visibility into market conditions.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.